The Board of the National Bank of Ukraine has decided to cut the key policy rate to 14%, effective from 28 October 2016. Further alleviation of risks to price stability has given the National Bank of Ukraine some room to further ease monetary policy, which was consistent with the need to achieve its inflation targets in 2017-2018.
In September 2016, annual inflation stood at 7.9% and was fully in line with the NBU’s forecast. The acceleration of headline inflation was mainly attributed to upward adjustments in administered prices.
At the same time, inflationary pressures, driven by fundamental factors, continued to ease, further contributing to the slowdown in core inflation to 6.3% y-o-y.
The deceleration in core inflation was underpinned by moderate consumer demand, high supply of food products due to abundant crops, and prudent monetary policy.
In October, FX supply exceeded demand in the FX market, enabling the NBU to purchase foreign currency to replenish international reserves without counteracting the appreciation trend.
The NBU has kept its headline inflation targets for 2016-2018 unchanged.
In Q4 2016, inflation is expected to return to the target level as a result of the reflection of upward adjustments in statistics for utility tariffs. At the same time, in the absence of significant unforeseen events, the NBU is on course to meet the year-end inflation target for 2016 (12% +/-3%).
Annual inflation is expected to follow an erratic path throughout 2017. In Q1-Q3 2017, inflation might exceed 12%, reflecting a statistical base effect and a high contribution from administered prices. As these effects wane, annual inflation is expected to return to the NBU target level in Q4 2017. At the same time, core inflation is expected to remain stable at 5-6%.
Therefore, the inflation targets for 2017 and 2018 (8% +/-2% and 6% +/-2 %, respectively) remain within reach and will be supported by the appropriate monetary policy.
In 2016, the economic growth forecast remained unchanged at 1.1%. In the medium-term, GDP is expected to grow at a more moderate pace than earlier expected: 2.5% in 2017 and 3.5% in 2018. The weaker GDP growth forecast reflects the revision of assumptions related to a worsened external environment for Ukrainian exporters.
A pick-up in investment activity is expected to be the key driver of economic growth. Lower risks of the escalation of military conflict stimulate economic agents’ appetite to make investment and long-term consumer decisions. However, this will lead to an increase in investment imports, including machinery and equipment. As a result, net exports are expected to make a negative contribution to GDP. However, going forward, a recovery in investment demand will help boost export potential.
At the same time, on the forecast horizon, higher investment activity is a key factor behind the upward revision in the current account deficit forecast at USD 2.5 billion in 2016, USD 2.9 billion in 2017 and USD 2.8 billion in 2018. In 2017-2018, the overall balance of payments is expected show a surplus supported by financial account net inflows, including FDI inflows.
These inflows, combined with expected disbursements of future IMF loan tranches, will increase international reserves up to USD 17.5 billion by the end of 2016, USD 23.1 billion by the end of 2017, and USD 27.8 billion by the end of 2018.
Further progress in advancing economic reforms under the IMF-supported program is critical for bringing inflation down to the target level and supporting economic recovery.
Should the baseline forecast scenario materialize and, accordingly, risks to price stability abate further, the NBU will continue to move ahead with monetary easing. This would help bring down borrowing costs and underpin economic growth.
The decision to cut the key policy rate to 14% is approved by NBU Board Decision No. 372-RSh, dated 27 October 2016, On The Key Policy Rate.
A detailed macroeconomic forecast will be published in the Inflation Report on 3 November 2016.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 8 December 2016.